Fed Ties Low Rates to 6.5% Unemployment Figure

By

Michael Aneiro

Dec. 12, 2012 12:32 p.m. ET

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Certainty! Actual, numerical certainty (or, at least, a bit more clarity). The Federal Reserve just for the first time tethered its zero-rate policy to specific economic indicators, effectively saying ultra-low short-term interest rates will last as long as the unemployment rate remains above 6.5% (it's currently at 7.7%). This comes after eons of tying the policy to long-term date ranges (most recently mid-2015) or loosely defined targets for improved economic conditions. The Fed also made new mention of a 2.5% inflation threshold.

Stocks, which often appreciate transparency, are up, while Treasury yields have jumped higher, with 10-year notes now down 10/32 in price to yield 1.685% and 30-year bonds down 1 2/32 to yield 2.891%, per Tradeweb data.

The Fed also effectively expanded its QE3-themed bond purchases to $85 billion per month, renewing its monthly purchases of longer-term Treasuries to the tune of $45 billion (its previous Operation Twist program had been set to expire) and maintaining its $40 billion monthly purchases of mortgage-backed securities. Key highlights from the Fed's policy committee statement:

[T]he Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. The Committee views these thresholds as consistent with its earlier date-based guidance. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.

For market reaction, we check in with Adrian Miller, head fixed-income strategist at GMP Securities:

With this statement, while the Fed has provided additional clarity as to what thresholds may result in a shift in policy, the language is still too vague necessary to better gauge the Fed's decision making process. For instance, there is no indication what would happen should the 6.5% unemployment threshold is breached if the driver was a continued contraction in the work force and not the result of a genuinely improved labor market.

As a result of a Fed who has embarked on an open-ended asset purchase program with little clarity as to when the punch bowl will be removed, the bond market has sold off due to inflation concerns.

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